Today, the Commission considers efforts to safeguard the resilience of four swap dealers in the European Union (“EU”).[1]  The proposal is part of the Commission’s “substituted compliance” framework—a framework that promotes global harmonization with like-minded foreign regulators that have rules, supervision and enforcement that are comparable in purpose and effect to the CFTC.  Our capital rules are a critical pillar of the Dodd-Frank Act reforms.  We must ensure that our comparability assessments are sound and do not increase risk to U.S. markets.

The CFTC’s capital framework for swap dealers heeds the lessons of the 2008 financial crisis.

The 2008 financial crisis precipitated the failure or near-failure of almost every major investment bank and a number of systemically important banks.  It demonstrated all too clearly the financial stability risks presented by undercapitalized financial institutions, including a sprawling network of globally interconnected derivatives dealers.  That is why Congress mandated that the Commission establish capital requirements for non-bank swap dealers.  The Dodd-Frank Act provided that swap dealer capital requirements should “offset the greater risk to the SD . . . and the financial system arising from the use of swaps that are not cleared”[2] and “help ensure the safety and soundness of the SD.”[3]  The Commission’s capital requirements, adopted in 2020,[4] are intended to do exactly that.

Our capital requirements promote the resilience of swap dealers and protect the U.S. financial system.  They ensure that swap dealers can weather economic downturns, and remain resilient during periods of stress to continue their critical market functions.  Our capital requirements also help prevent contagion of losses spreading to other financial institutions.

The CFTC must ensure that capital requirements eligible for substituted compliance are comparable in outcomes, supervision, and enforcement.

The Commission has to proceed cautiously given the importance of capital to financial stability, the complexity of capital frameworks, the interconnected nature of global derivatives markets, and the speed of contagion in the global financial system.

First, we have to ensure that our substituted compliance framework recognizes only those frameworks that are comparable with respect to the most fundamental outcome—the amount of capital required to support a swap dealer’s activities.  The substituted compliance framework must result in the application of capital rules that are legitimately a substitute for the capital protections provided by U.S. law.

Second, the fact that a foreign regulator may have comparable capital rules will not be enough.  We have to look beyond the four corners of rules.  Substituted compliance requires a like-minded foreign regulator with comparable supervision and enforcement to the CFTC.

Our substituted compliance decisions should not allow for regulatory arbitrage for swap dealers to escape strong U.S. capital rules—a situation that could erode Dodd-Frank Act post-crisis reforms.  I served as the Special Inspector General for the Troubled Asset Relief Program (“SIGTARP”) for more than a decade, providing oversight over the U.S. Government’s unprecedented taxpayer-funded injections of hundreds of billions of dollars in capital into Wall Street as a response to the 2008 financial crisis.  I have testified before Congress and reported to Congress about how inadequate capitalization at the largest banks contributed to the financial crisis, how the significant interconnections between financial institutions posed systemic risk, and the painful toll the crisis took on hardworking America families and small businesses.

All four swap dealers who would be able to avail themselves of our determination today are affiliated with the largest TARP recipients.  That fact alone is a good reminder of what is at stake in terms of risk.  It is not just danger to financial institutions, but also American families and businesses.  Under this proposal in addition to the Commission’s two prior capital comparability proposals,[5] 10 of 106 registered swap dealers would be eligible to rely on substituted compliance.[6]

Strong capital requirements and areas where the Commission would particularly benefit from public comment.

Three of the four EU swap dealers are dually-registered with the U.S. Securities and Exchange Commission (“SEC”).  The SEC has issued final comparability determination orders permitting them to satisfy certain SEC capital requirements through substituted compliance with applicable French and German requirements.[7]

In conducting the CFTC’s own analysis, it is important to remember that substituted compliance is not an all-or-nothing proposition.  The Commission retains examinations and enforcement authority and it can, should, and will, impose any conditions and take all actions appropriate to protect the safety and soundness of swap dealers and the U.S. financial system.  Today, the Commission proposes 24 conditions, including conditions requiring capital reporting and Commission notification that are essential to monitoring the financial condition and capital adequacy of swap dealers.

Just as with swap dealers in Japan and Mexico,[8] one of the most important conditions is that the Commission will continue to require compliance with the CFTC’s minimum capital requirement of $20 million in common equity tier 1 capital.[9]  This is one of the most critical components of the CFTC’s capital requirements.  It helps to ensure that each nonbank swap dealer, whether current or a future new entrant, maintains at all times, $20 million of the highest quality capital to meet its financial obligations without becoming insolvent.

Today, the Commission preliminarily finds that EU capital rules requiring 8 percent of risk-weighted assets and an additional 2.5 percent buffer, for a total of 10.5 percent, are higher than the CFTC’s requirement of 8 percent of risk-weighted assets.  This capital requirement helps ensure that the swap dealer has sufficient capital levels to cover for example, unexpected losses from business activities.

There are proposed deviations from the Commission’s bank-based capital requirements that should be closely scrutinized.  For example, the Commission proposes to permit compliance with EU capital rules that are not necessarily anchored by a threshold percentage of uncleared swap margin as the CFTC requires.  I note that EU capital rules address liquidity, operational risks, as well as other risks arising from derivatives exposures, through other mechanisms.  I look forward to public comment on the comparability of the approaches.

In these areas, and others, public comments will be tremendously beneficial.  I approve.

[1] The four swap dealers in the European Union are located in France and Germany—BofA Securities Europe SA (France), Citigroup Global Markets Europe AG (Germany), Morgan Stanley Europe SE (Germany), and Goldman Sachs Paris Inc. et Cie (France).

[2] 7 U.S.C. 6s(e)(3)(A).

[3] 7 U.S.C. 6s(e)(3)(A)(i).  The capital requirements also must “be appropriate to the risk associated with non-cleared swaps.”  7 U.S.C. 6s(e)(3)(A)(ii).

[4] See Commodity Futures Trading Commission, Capital Requirements of Swap Dealers and Major Swap Participants, 85 Fed. Reg. 57462 (Sept. 15, 2020), 2020-16492.pdf (govinfo.gov).

[5] See Commodity Futures Trading Commission, Notice of Proposed Order and Request for Comment on an Application for a Capital Comparability Determination from the Financial Services Agency of Japan, 87 FR 48092 (Aug. 8, 2022); See also Commodity Futures Trading Commission, Notice of Proposed Order and Request for Comment on an Application for a Capital Comparability Determination Submitted on behalf of Nonbank Swap dealers subject to Regulation by the Mexican Comision Nacional Bancaria y de Valores, 87 FR 76374 (Dec. 13, 2022).

[6] 55 of the 107 swap dealers are subject to U.S. prudential regulatory capital requirements.

[7] See Amended and Restated Order Granting Conditional Substituted Compliance in Connection with Certain Requirements Applicable to Non-U.S. Security-Based Swap Dealers and Major Security-Based Swap Participants Subject to Regulation in the Federal Republic of Germany; Amended Orders Addressing Non-U.S. Security-Based Swap Entities Subject to Regulation in the French Republic or the United Kingdom; and Order Extending the Time to Meet Certain Conditions Relating to Capital and Margin, 86 Fed. Reg. 59797 (Oct. 28, 2021); Order Granting Conditional Substituted Compliance in Connection with Certain Requirements Applicable to Non-U.S. Security-Based Swap Dealers and Major Security-Based Swap Participants Subject to Regulation in the French Republic, 86 Fed. Reg. 41612 (Aug. 8, 2021); and Order Specifying the Manner and Format of Filing Unaudited Financial and Operational Information by Security-Based Swap Dealers and Major Security-Based Swap Participants that are not U.S. Persons and are Relying on Substituted Compliance with Respect to Rule 18a-7, 86 Fed. Reg. 59208 (Oct. 26, 2021).

[8] See CFTC Commissioner Christy Goldsmith Romero, Proposal for Strong Capital Requirements and Financial Reporting for Swap Dealers in Japan, (July 27, 2022) Statement of Commissioner Christy Goldsmith Romero Regarding the Proposal for Strong Capital Requirements and Financial Reporting for Swap Dealers in Japan | CFTC; See also CFTC Commissioner Christy Goldsmith Romero, Promoting the Resilience of Swap Dealers in Mexico Through Strong Capital Requirements and Financial Reporting,  (Nov. 10, 2022) Statement of Commissioner Christy Goldsmith Romero on a Proposed Comparability Determination for Capital | CFTC.

[9] This CFTC capital rule substantially exceeds the EUR 5 million minimum capital required under EU capital rules.